If Options Traders Are Right, the Yuan's Slump Is Far From Over

  • Contracts indicate 33% odds of drop to 7 per dollar this year
  • `Explosive' growth seen in bearish bets, currency trader says

The options market is signaling that the yuan’s slide to a five-year low has plenty of room to run.

Contractprices on Wednesday indicated a 79 percent probability that the currency will weaken and 33 percent odds that it will drop beyond 7 per dollar, a rate last seen in 2008, according to Bloomberg calculations. That’s up from 15 percent at the start of December and comes as the central bank shows signs of reining in its support for the exchange rate in the face of rising intervention costs and sliding exports. The yuan dropped 0.6 percent in onshore trading at 4:07 p.m. local time after the central bank cut its reference rate.

“We’ve seen explosive growth in demand for options betting the yuan will weaken as clients seek protection against further depreciation," said Frank Zhang, Shanghai-based head of foreign-exchange trading at China Merchants Bank Co., which trades yuan options. "The situation won’t get better until market sentiment stabilizes in the spot market, which isn’t going to happen in the next few months."

The People’s Bank of China has been burning through its foreign-exchange reservesto prop up the yuan, with the stockpile recordingits first-ever annual decline last year, as the central bank sold dollars both in the onshore and offshore markets. The support has been more sporadic since December after China succeeded in persuading the International Monetary Fund to admit the yuan into its reserves basket.

The odds of the yuan breaking beyond 7 to the greenback by the end of March jumped to 11 percent from 5.8 percent. The notional value of outstanding put options carrying the right to sell the yuan at exchange rates of 7 or higher has climbed to $142 billion from $120 billion, Depository Trust & Clearing Corp. data show.

China is due to report foreign-currency reserves on Thursday, with the median estimate in a Bloomberg survey predicting a $23 billion decline in December. Government data next week are forecast to show Chinese exports shrank for a sixth straight month in December. The private Caixin Media and Markit Economics Chinese services gauge fell to a 17-month low, according to a report released Wednesday.

While bearish bets are building in yuan derivatives, only one out of 39 analysts in a Bloomberg survey predicted a slide to 7 per dollar in 2016. The median estimate is for a 0.6 percent retreat to 6.6. Goldman Sachs Group Inc. said this week that it sees “limited” room for further depreciation as slumping energy prices will help boost China’s current-account surplus and offset capital outflows.

The yuan closed at 6.5555 per dollar on Wednesday in Shanghai and options prices indicated a 75 percent chance it will be weaker than 6.60 come year-end. The odds of a drop beyond 7 in the current quarter have doubled to 12 percent since the start of December.

China’s central bank cut its yuan reference rate by 0.5 percent, the most since August, to 6.5646 per dollar on Thursday. The currency last traded at 6.5938 in the onshore market.

After the IMF entry, the yuan has become a “one-way bet, and the market has figured out that it’s a one-way bet,” Richard Jerram, chief economist at Bank of Singapore, said at a press briefing in Hong Kong on Wednesday. “It’s a dangerous situation for policy makers.”

— With assistance by Tian Chen

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